Distribution of assets part II: Proactive steps for a fair split

As discussed in our previous post, When is an Equal Distribution of Assets a Bad Idea?, available here, splitting assets does not always work out as we may intend. This post will discuss some proactive steps you can take to better ensure an equal inheritance.

Retirement assets and tax obligations, step one: The Internal Revenue Service (IRS) does not treat all retirement assets equally. As discussed in the post noted above, the first impact involves whether the retirement account was a taxable investment or tax deferred.

Retirement assets and tax obligations, step two: The second consideration requires the giftor to review the intended beneficiary’s financial situation. Beneficiaries may fall into different tax rates. In these cases, the IRS will tax each recipient’s inheritance differently.

Let’s go back to Bob and Judy, the scenario family in our first post in this series. Bob and Judy have two children, Jake and Jane. Jake is a teacher at a local high school and Jane is a dermatologist. Jake has a taxable income and pays the IRS a 12 percent tax rate. In contrast, Jane pays the IRS 37 percent.

Bob and Judy intend to leave each a $1 million inheritance. If this inheritance is part of a taxable investment, like an IRA, the “inherited” tax liability will result in an uneven inheritance. If gifted a taxable investment like an IRA, Jake’s inheritance will be reduced by the 12 percent tax obligation while Jane’s will be reduced by 37 percent.

This is problematic for two reasons:

  • The inheritance is not even, as intended
  • The inheritance is subject to an avoidable tax bill

Bob and Judy can implement a number of tax planning strategies to better ensure an equitable inheritance. The couple could consider making the most of converting traditional IRAs into Roth IRAs during their lifetime to reduce the tax obligations passed on to their heirs or determine an initially unbalanced mix of taxable and tax deferred assets that result in an equal distribution after tax obligations are taken into account.

These are just a few options that can help you meet your estate planning needs. An attorney experienced in these matters can help tailor a plan that better ensures your wishes become reality. 

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